Q1 2024 International & Global Growth Funds Commentary
Market Recap
Global equity markets staged another broad rally for a second consecutive quarter. The U.S. market led again globally, followed by international developed markets, and then emerging markets. Additionally, growth style stocks again outperformed value style stocks. Interest rate cuts for the Federal Reserve and other major central banks have been pushed out, but they are still broadly predicted. Equity markets rallied despite the hawkish repricing of Fed estimates.
We invest with a long-term time horizon that can look through shorter-term economic perturbations. Furthermore, our investment philosophy emphasizes businesses that benefit from secular trends and possess strong competitive advantages and market positions. We purposefully select portfolio companies that earn attractive profit margins, carry strong balance sheets, and generate cash on a consistent basis. We believe these attributes hold tack even if the macro backdrop is soft or deteriorating. And we deploy this strategy in concentrated and conviction-weighted portfolios. For these reasons, portfolios have the ability to outgrow market growth rates over an investment cycle.
In this inflationary environment, we have continued to make ongoing adjustments to emphasize holdings that we believe are well-suited to transmit pricing power or are valued more attractively. These attributes should help protect against two of the most pernicious effects of inflation for equity investors: compression of profit margins and compression of valuation multiples.
In the first quarter of 2024, the Baird Chautauqua International Growth Fund Net Investor Class returned +5.02%, outperforming the MSCI ACWI ex-U.S. Index® ND, which returned +4.69%. The Baird Chautauqua Global Growth Fund Net Investor Class returned +9.15% during the quarter, outperforming the MSCI ACWI Index® ND, which returned +8.20%.*
Outlook
Global growth is set to remain modest, with the impacts of tight monetary policies and soft business and consumer confidence all being felt. A growing divergence across economies is presumed to persist in the near term. There continues to be mild near-term growth in most major economies, relative weakness in Europe, and clear signs of strong near-term momentum in India and Indonesia. Consumer confidence also remains subdued relative to longer-term norms in many developed economies, as well as in China, but it has held up better in other emerging market economies.
According to the Organization for Economic Cooperation and Development (OECD), global GDP growth of 3.1% in 2023 will be followed by a mild slowdown to 2.9% in 2024. Compared with earlier projections, these growth numbers have been revised up, largely on account of upside surprises, particularly in the U.S., in late 2023. Still, this would be the third consecutive year of growth moderation. GDP growth in the U.S. is projected to moderate to 2.1% in 2024. In the eurozone, GDP growth is projected to be 0.6% in 2024. Asia is predicted to continue to account for the bulk of global growth in 2024. China is estimated to slow to 4.7% in 2024, on the back of ongoing stresses in the real estate sector and subdued consumer demand. GDP growth is projected to be more than 6% for India and 5% for Indonesia.
Headline inflation has fallen in almost all economies. Core inflation has also fallen but remains high. Global demand is easing, supply disruptions are fading, and commodity prices are moderating, while monetary policies remain restrictive. In the absence of further adverse supply shocks, cooling demand and the ongoing effects of prior rate hikes should allow headline and core inflation to fall further in most economies. In some countries, annual headline inflation has already fallen back to or below official targets. However, with core inflation still above target in most countries, it is too soon to declare that the coast is clear.
Economic conditions among the emerging market economies are very diverse. China continues to struggle with its property sector, and successive waves of stimulus have aimed to offset that sector’s ongoing contraction. Meanwhile, low consumer confidence in the country and its high savings rates have hindered the growth of private consumption. In contrast, GDP growth in the other major Asian emerging economies, including India and Indonesia, is projected to expand in 2024.
Over the last two-plus years, we have reduced Greater China weightings on a net basis, inclusive of holdings in Mainland China, Hong Kong, and Taiwan. In International portfolios, roughly 17% of assets are invested in Greater China holdings, which is modestly overweight relative to the benchmark. In Global portfolios, roughly 11% of assets are invested in Greater China holdings, which is overweight relative to the benchmark. We believe our Chinese holdings are at valuation levels, in the context of their long-term growth outlooks and competitive positioning, that more than compensate us for the risks. Our Chinese holdings are exposed to secular growth areas of the domestic economy (private consumption and health care) that align with government priorities, have strong balance sheets and resilient cash flows, and are not reliant on restricted Western technology inputs for future growth.
Our investment philosophy emphasizes businesses that should benefit from secular trends and possess strong competitive advantages and market positions. Over longer investment horizons, some of the most exciting growth areas can be relatively agnostic to the global picture or the specific situations impacting certain regions. These include our many investments in and adjacent to cloud computing, software-as-a-service, digitalization, artificial intelligence, semiconductor advancement, e-commerce and payments, industrial automation, electric vehicles, and novel biologic and biosimilar therapies. Other exciting growth areas pertain to rapidly expanding consumer classes, broadly in emerging economies and especially in Asia, which are propelling the uptake of various consumer goods and financial products.
We do not anticipate the current environment of weakening economic growth will dislodge the long-term staying power of these investment themes, nor the business models or market positions of portfolio companies. Furthermore, we purposefully select portfolio companies that earn attractive profit margins, carry strong balance sheets, and generate cash on a consistent basis. In other words, portfolio companies we believe are on solid footing, even when times are tough. For these reasons, portfolios have the potential to outgrow market growth rates over the long-term.
We have also taken great care to try to insulate against the most pernicious risks that inflation poses to equity investments, namely pressure on company profit margins and compression of valuation multiples. First, we have emphasized companies that we believe have pricing power because of the mission-critical or value-add nature of their products and services. Because of these features, these companies are able to transmit price in inflationary environments, and therefore protect their profit margins. Furthermore, we have made incremental adjustments to portfolios to emphasize companies with more attractive valuations, in light of higher market discount rates.